Understanding the FOMC Statement

If you were expecting to be enlightened about the Fed‘s monetary policy stance but instead ended up even more confuzzled, then you are not alone! Many are still trying to decode the Fed’s mixed signals and make sense of its recent FOMC statement.

Of course, no one was really expecting the Fed to raise interest rates or implement any form of policy tightening, not with the economy in the frail state that it’s in. Most, if not all, market participants had a dovish bias for the statement.

While the chances of seeing the Fed increase its asset purchases were always slim, it was widely believed that the central bank would at least hint about easing monetary policy in the future. But surprisingly, it didn’t!

Not only did the Fed pass up the chance to boost the economy with more easing, but it even sounded somewhat optimistic about the economy’s performance last quarter. To the surprise of many, Fed Chairman Ben Bernanke said that the economy had “strengthened somewhat” in Q3 2011. This suggests that the Fed has a bit of leeway to evaluate just how effective its actions in August and September were in stimulating the economy.

Before you get too excited, you should know that it wasn’t all A-okay!

For one, not everyone in the FOMC was in agreement with the head honcho. Chicago Fed President Charles Evans voted for further easing. Considered as the most dovish FOMC member, Evans has always been pretty open about his worries about the lackluster state of the labor market. So I guess it wasn’t much of a surprise to hear him call for further stimulus for the second meeting in a row.

Although the rest of the FOMC didn’t join Evans on the dovish side of the debate, they seem to agree with him on the dreary employment conditions in the country. The FOMC stated that it expects the unemployment rate to remain at 9.1% at the end of 2011 and it won’t be until the latter part of 2012 that it would trickle lower to 8.6%.

It’s also interesting to point out that despite the optimistic vibes of the statement, the Fed downgraded its growth forecasts. Before, policymakers were expecting the U.S. economy to expand by 2.7% to 2.9% by the end of 2011 and 3.3% to 3.7% in 2012. Now, they see this year’s growth coming in between 1.6% to 1.7% and growth for 2012 to fall between 2.5% to 2.9%.

So with the mixed news, how did the dollar react?

Well, it seems like the Fed’s optimistic tone allowed the dollar to rally against most of its major counterparts. The USDX, which measures the performance of the dollar against a basket of currencies, traded higher following the release of the statement as the optimistic remarks suggest a less pressing need for QE3.

BUT! I doubt that the Fed lowered its growth forecasts just to make its statement more dramatic. In this old man’s opinion, Bernanke and his buddies are still open to more stimulus and have not closed the door on QE3 yet.

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